Medtronic-Covidien: The End of the American Dream?

Medtronic’s ‘Rising Man’ symbol stands in front of the headquarters in Fridley, Minn.

Associated Press

Will the time come when the U.S. medical products industry is no longer headquartered in the U.S.?

The notion may sound far-fetched, but a growing number of drug and device makers are more than willing to abandon U.S. headquarters and the implications for the U.S. are sobering. One company after another has begun searching for acquisitions that would allow them to enjoy a lower tax rate by purchasing a rival based in certain foreign countries and then shifting headquarters there.

The maneuver has a technical name called tax inversion, but in reality, it’s all about tax aversion.

The Medtronic bid for Covidien may not come to pass, but a deal would lower its tax rate substantially. In Ireland, where Covidien is based, the main corporate tax rate is 12.5%, compared with a much higher 35% in the U.S., although both companies last year paid differing effective rates due to various tax considerations, according to The Wall Street Journal, which first reported news of the talks.

Clearly, this is not good news for the U.S. economy and American taxpayers. And some members of Congress, notably Democrats, want to change the tax laws to put a halt to inversions. Whether Congress has the will to make a fix is unclear, but there is little likelihood of this happening before next year, which explains the recent push by investment bankers to pitch these kinds of deals.

Drug and device makers do have other considerations, of course. There are rising costs and risks associated with developing new products, and increased pressure to lower prices. Device makers such as Medtronic, for instance, are grappling with cost cutting by hospitals as a consequence of the U.S. Affordable Care Act. These are the sort of pressing problems that spur consolidation talk, anyway.

These companies are within their rights to pursue deals that allow them to relocate headquarters in Ireland or the U.K. or wherever else they can get a lower tax rate. As the former chief executive of one very large drug maker, who asked not to be named, recently told us, “It really doesn’t make sense to pick on Pfizer. If you don’t like the law, change it.”

Fair enough. But the deals raise another troubling thought. Even though these drug and device makers may, otherwise, remain based in the U.S., they may later have divided loyalties. Consider that Pfizer was pressed by the U.K. government for assurances about maintaining a certain level of employment and R&D investment in the country if AstraZeneca had been acquired.

Such demands raise the possibility that future investment – in labs, manufacturing plants, equipment and hiring – would not go to the U.S. but to the country where headquarters was transferred. In this instance, Pfizer would have moved headquarters to the U.K. Whether other deals would require such commitments to foreign governments is another matter. But the issue could be on the table.

There is irony here. Despite switching domiciles, drug and device maker stocks can remain on the S&P 500. The companies can avail themselves of U.S. laws protecting intellectual property. And executives can stay put. Last year, Actavis executives chuckled at the thought of moving to Ireland after buying Warner-Chilcott. “Everybody loves New Jersey too much,” said Paul Bisaro, the Actavis chief executive.

This also helps to explain why more tax inversions appear likely. Granted, it is a stretch – and then some – to suggest the entire U.S. medical products industry will shift headquarters to foreign countries. But you can be certain that other drug and device makers find the concept intriguing, if not seductive. Given the right opportunity, they have a responsibility to shareholders to consider such a move.

Comments (5 of 24)

Who cares? The taxes just go to pay the interest on the debt to the private banking cartel otherwise known as the "federal reserve." When are people going to wake up?

9:12 pm June 17, 2014

Merwyn wrote:

Good riddance to COV. Parasite mis-management group squeezed and sucked the life out of their US employees and USA plant sites. Then they discard them. Just being profitable is not enough anymore. . Now it is their turn. And I hope they find another Red Sox team to sponsor in China.

3:55 pm June 17, 2014

Pete wrote:

It's a misconception that moving corporate headquarters will allow earnings to be taxed at a lower rate. All earnings will still be taxed at the rates in the countries where the sales were made. These tax rate differences as well as the product sales mix are what leads Medtronic to have an average tax rate of 18% while Covidien has one of 16%. These rates won't change at all as a result of this headquarters move. They can only change as a result of the country to country product mix changing or tax rates in individual countries changing. Unless I'm mistaken, what this does allow Medtronic to do is to bring the OUS earnings of Covidien back in to the US without paying the surplus tax that the US charges to make up the difference between what taxes have been levied against those dollars OUS and what the US tax rate is. In my mind this secondary taxing by the US government on earnings made outside the US shouldn't be allowed in the first place. Avoiding this extra tax will allow MDT to invest more money in the US in R&D and acquisitions, leading to more US jobs and a healthier US economy.

2:13 pm June 17, 2014

Chris wrote:

What do taxes and Intellectual property have to do with eachother? Any foreign company / Individual can file for a US Patent and sue in the US courts for infringement. Same as any US company can file a patent in Germany, or China and use the foreign courts for infringement.

10:56 am June 17, 2014

pharma apologist wrote:

No, Joe. Not a dying industry, just a mature one. Mature companies die only when they fail to reinvent themselves. We are finding new markets for old drugs every day. We grease the right palms of the Chinese and voila the drugs fins their way to the peasants. We have found that size doesn't matter. We have gotten smaller and have defied the axiom that you can't cut your way to profitability. The one billion tax saving that Pfizer would have made can be easily managed by cutting another 7500 jobs based on my calculations.

About Pharmalot

Pharmalot explores the fast-moving, complicated world that develops and markets medicines – and the drug makers that are attempting to replenish their pipelines while grappling with pricing and regulatory dictates, among many other challenges. Writer Ed Silverman has covered the pharmaceutical industry for nearly two decades and has closely followed the many hurdles facing drug companies as they move ideas from the laboratory to the medicine chest. He started Pharmalot while at The Star-Ledger of New Jersey and previously worked at New York Newsday and Investor’s Business Daily. Email Ed Silverman at ed.silverman@wsj.com, and follow him on Twitter @Pharmalot.